A business partnership can be somewhat complicated. Partners have many benefits from establishing a company as a partnership, but there are many issues that you must resolve for a smooth agreement. One of the most important considerations is how to handle a partner’s shares in the business if he or she leaves the company. The partner may leave through retirement, or for other reasons, or might pass away. When that happens, it is essential to look to the buy-sell agreement that you have put in place ahead of time.
Why You Need a Buy-Sell Agreement
A buy-sell agreement is a legal contract that establishes how a business partner’s shares are to be handled when the partner dies or leaves the business. It is an essential part of a business contract between partners. The agreement is also called a buy and sell agreement. A good buy-sell agreement provides for an orderly transition in the event a partner leaves the business. The agreement is necessary to make sure that the business will continue to thrive without conflict. Generally, a buy-sell agreement may include a formula that you can use to properly divide shares in the business.
Types of Buy-Sell Agreements
It is helpful to understand the types of buy-sell agreements so you can choose the type that works best for your company. There are various types of buy-sell agreements. The three most common buy-sell agreements are cross-purchase, stock redemption, and combination.
- Cross-Purchase: A cross-purchase buy-sell agreement allows you and your partners to purchase shares of the person leaving the business. Existing partners may decide to purchase the shares in any way they prefer as long as it meets the guidelines defined in the agreement.
- Stock Redemption: A stock redemption agreement provides for the company to purchase the shares of the departing partner. Your business could thereby sell the shares to an existing partner or bring a new partner into the business.
- Combination: A combination buy-sell agreement is one in which shares from the departing partner may be purchased by the remaining partners or by the company, or by both. Existing partners may purchase shares and the remaining shares are purchased by the company.
What to Know About Buy-Sell Agreements
Buy-sell agreements should be as detailed as possible to provide adequate direction to the partnership members. It is important to note that a buy-sell agreement allows for how to divide shares in the business but may not account for the finances. You or your company need to have the money necessary to purchase shares in the business. It is helpful if the agreement includes options for funding the buyout of shares. In some cases, it may be beneficial to have a life insurance policy on partners so it will provide the funds necessary for share purchase.
The agreement should include a valuation formula that you can use to determine the current value of shares. The agreement may also include a list of events, other than death, that could trigger the buy-sell agreement to take effect. It is helpful to plan ahead to determine the best ways to reduce tax obligations.
Buy-sell agreements don’t have to be complicated, but you should have one in place for your company. To establish a buy-sell agreement for your company, contact our legal team at Moen Sheehan Meyer, Ltd. at (608) 784-8310 or online for a consultation.